Private fund fees and conflicts: SEC scrutiny and referral rewards

How should a PE firm treat referral compensation tied to portfolio companies?

Treat it as a conflict to be identified, disclosed and approved under the fund's own documents, not as a private side income. The Private Fund Adviser Rules were vacated by the Fifth Circuit in June 2024, so those specific requirements are not in force, but an adviser's fiduciary duty, the antifraud provisions and the fund documents still require accurate disclosure of fees, expenses and conflicts, and examiners continue to look at them.

This is general information, not legal, tax or financial advice. Confirm with your own counsel, tax adviser or professional body before acting.

What was vacated and what was not

The 2023 Private Fund Adviser Rules would have added requirements such as quarterly fee statements, restrictions on certain charges and preferential-treatment disclosures. The Fifth Circuit vacated them in June 2024. Read the court's opinion and the SEC's current statements on the status of those rules; this page does not rely on any specific rule text.

What remains is more important for a sponsor deciding whether to take a reward.

• Fiduciary duty. An adviser owes its funds duties of care and loyalty, which include full and fair disclosure of conflicts.
• Antifraud provisions. Misleading or incomplete statements to investors about fees and expenses can be enforcement matters irrespective of the vacated rules.
• Fund documents. The limited partnership agreement, side letters and the management company's compliance manual often say what happens to fees from portfolio company dealings, such as offsets, rebates and approval by an advisory committee.
• Examinations. Examiners ask how advisers identify and disclose fees, expenses and conflicts. A referral reward connected to portfolio companies belongs in that file.

Why this matters now

Operational value creation has become the center of PE returns. McKinsey's global private markets report says multiple expansion and cheap leverage, which accounted for 59 percent of PE returns between 2010 and 2022, have faded, so operational value creation is now likely the primary source of returns. More operating teams means more portfolio-level programs, and more questions about who is paid for what.

Bain reports that buyout holding periods at exit are around seven years, up from an average of five to six years in 2010 to 2021. Longer holds mean more years in which a portfolio company relationship can generate payments the investors should hear about.

A decision table for referral rewards

Choosing a treatment

There are three common treatments, and which is open to you depends on your documents.

1. Decline the reward. The portfolio company licenses data on its own merits and no one at the sponsor is paid. This removes the conflict.
2. Credit it to the fund or the company. The reward goes to the fund or is offset against management fees, if the documents allow.
3. Disclose and keep. The reward is disclosed to investors and the advisory committee and retained by the management company or individual as the documents permit.

A fourth route is not an option: taking the reward without telling anyone.

What to document

• Date, parties and terms of the referral arrangement
• Which portfolio companies were introduced, and whether each decided independently
• The compliance officer's written analysis of conflicts and fee treatment
• Advisory committee or LP disclosure, if made
• How the reward was paid, offset or declined
• Training or instruction to deal team members to avoid influencing the portfolio company's decision

What to say to your CCO

How rewards work

Partners earn 25% of the eligible platform fees SourceX actually collects from the referred company's licensing deals, capped at $100,000 per referred company. The reward is paid only after the buyer pays and SourceX receives its fee; an introduction, meeting or signed agreement alone does not trigger payment, and no reward is guaranteed. The reward is a share of SourceX's fee and is never deducted from what the portfolio company receives. Terms are in the program terms; for the sponsor-side view of fees, read the page for search funds and independent sponsors.

When not to introduce a portfolio company

• Your fund documents prohibit side compensation and no waiver is available.
• The company is below the 50+ full-time employees at peak (contractors excluded) baseline or lacks rights to license its records.
• The introduction would pressure management to license against its own judgment.
• Compliance has not signed off.

For comparison, see how consultants and restructuring officers approach the same problem. The company fit checker is a non-binding first screen.

Questions to ask your counsel

• Do our fund documents treat fees from portfolio company dealings as offsets, and does a referral reward count?
• Does our compliance manual list third-party rewards as a conflict, and who approves exceptions?
• Would the advisory committee expect to approve this before the first introduction?
• Are there investors with side letters that require notice of any compensation tied to portfolio companies?
• If an examiner asked for every payment connected to portfolio companies, would this one be in the file?

Illustrative walk-through

Illustrative: a lower-middle-market sponsor has six portfolio companies, two with more than 50 full-time employees at peak (contractors excluded) and years of archived support and project records. The head of portfolio operations proposes mentioning the program to both CEOs. The CCO asks for a one-page memo and decides that any reward will be credited against management fees under the existing offset clause, that the advisory committee will be told at its next meeting, and that the head of operations will not be involved in either company's decision. Both CEOs hear about the program with the same disclosure and decide for themselves.

Next step

Take the decision table to your CCO and general counsel, then register as a partner once the treatment is settled. The wider view for sponsors is on the operating partner page.